S&P Upgrades Nokia (NOK) to 'BB+' Following Alcatel-Lucent (ALU) M&A News

Standard & Poor's Ratings Services today raised its long-term corporate credit rating on Nokia Corp. (NYSE: NOK) to 'BB+' from 'BB'. The outlook is positive.

We also affirmed the 'B' short-term rating on Nokia.

At the same time, we raised our issue rating on Nokia's senior unsecured notes to 'BB+' from 'BB'. The recovery rating is '3', indicating our expectation of meaningful recovery (in the lower half of the 50%-70% range) in the event of a payment default.

The upgrade primarily reflects Nokia's solid operating results and free cash flow generation in 2014 and resilient prospects for 2015, which are better than we expected in our previous base case. As a result, we have raised our business risk assessment to "fair" from "weak" and will deduct surplus cash from Nokia's Standard & Poor's-adjusted gross debt obligations going forward. In addition, we expect the company will continue to follow a conservative financial policy, including the maintenance of a strong net cash position. At year-end 2014, Nokia reported gross cash and short-term investments of €7.7 billion and a net cash position of €5.0 billion.

Furthermore, despite being margin-dilutive and creating meaningful integration challenges in the near term, we view the proposed merger with French-American telecommunications equipment supplier Alcatel-Lucent overall as potentially credit-positive in the medium term. This is because the transaction is structured as an all-share transaction. In addition, in the fourth quarter of 2015, Nokia intends to use the soft call option for its €750 million convertible bond due 2017, and we expect all of Alcatel-Lucent's outstanding convertible bonds to be converted into equity and exchanged with newly issued ordinary shares of Nokia.

In our view, the combined entity will have a more diversified business portfolio and will be one of the market leaders in wireless, fixed-line access, internet protocol (IP) routing and fiber optics transmission, and core network technologies. In addition, the enlarged group's profitability should benefit from sizable cost synergies over the next few years, particularly for research and development (R&D) expenses in wireless operations.

The transaction is expected to close in the first half of 2016. Post the closing, Alcatel-Lucent shareholders will own about 33.5% of the combined group.

The positive outlook reflects the potential for a one-notch upgrade in about 12-18 months if Nokia successfully executes the proposed merger with Alcatel-Lucent, is likely to achieve the targeted cost synergies, and maintains a very conservative balance sheet.

We could raise the rating if the combined entity is able to demonstrate revenue growth about in line with the industry, Standard & Poor's-adjusted EBITDA margins of about 10%, as well as sustained positive discretionary cash flow. In addition, an upgrade would be supported by a Standard & Poor's-adjusted debt-to-EBITDA ratio of below 1x and FFO to debt above 65%.

We could revise the outlook to stable if the combined entity is likely to report Standard & Poor's-adjusted EBITDA margins sustainably below 10% due to strong competitive price pressure, market share losses, or higher than expected restructuring costs. In addition, significant negative discretionary cash flow generation or a meaningful deterioration of the group's net financial cash position could lead us to revise the outlook to stable.

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